DEALMAKER GUEST BLOG -- SCOTT L. MCRILL

As states grow hungrier for revenue, assessing tax impact of deals even more critical

Blog Entry: February 27, 2013 4:30 AM | Author: SCOTT L. MCRILL

Scott L. McRill is director of the transaction advisory services group at SS&G. His practice is focused mainly on advising private equity and corporate clients across a wide range of industries on both the buy and sell side of transactions.

In the fast-paced environment of dealmaking, it is becoming more important to take into account the state tax implications of a deal.

Regardless of whether you are on the sell side or buy side, it is important to understand what the target company is doing in a state in order to determine whether a state has the ability to tax the company in the past, present or future.

When there is a substantial connection between a taxpayer's activities and a state, state law refers to this connection as establishing “nexus” with the state. Traditionally, most states have interpreted nexus by considering whether the company has some sort of physical presence.

As state resources tighten, some states have moved from requiring a physical presence toward an economic presence nexus standard or factor presence nexus standard. Economic presence is based on a state-specific threshold of sales, property or payroll sourced to the state. If the target business meets that specific threshold, then it can be subject to a filing requirement and potential tax liability.

State laws differ on how nexus is determined, which is why understanding the target's business is so critical.

In addition to determining whether the target company has nexus and therefore tax filing obligations in a state, in any transaction it is important to investigate whether there are any hidden taxes that might impact the deal.

These differ depending on whether the transaction is an asset deal or a stock deal. For an asset deal, if the buyer is going to buy real estate, many states impose transfer taxes on the sale. Additionally, sales tax on the transfer of assets is critical for a buyer. States such as Illinois and New York have extremely stringent guidelines that must be followed so that any sales tax liability exposure does not transfer to the buyer upon acquisition.

For stock deals, sometimes the tax liability exposure can be higher because there are more types of taxes that need to be taken into account. Generally, income, franchise, sales and use, personal property, and payroll taxes are considered in tax due diligence.

However, state unclaimed fund reporting and international filings are increasingly becoming areas of concern. Most states have an unclaimed property fund law, which requires all businesses that operate in a state to report all intangible property unclaimed by its owner on an annual return. Additionally, many companies are selling internationally, which, depending on the extent of the business being performed, may require a U.S. treaty-based return at a minimum.

Since the buyer assumes responsibility for all tax obligations in a stock deal, the key is to make sure that there is enough escrow held back in the deal to cover the buyer in the event that a state comes after the buyer after the deal is done.

As the economy slowly recovers, states are becoming much more aggressive in trying to find additional sources of money. Therefore, it becomes critical to make sure that tax due diligence includes a strong emphasis on state and local taxation.

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